Marketplace lenders: The law of agency

WebBank of Salt Lake City, Utah; Cross River Bank of Teaneck, New Jersey; NBT Bank of Norwich, New York and Comenity Capital Bank of Columbus, Ohio: these are hardly household names. But their involvement with the new breed of online marketplace lenders has arguably been far more important than that of the likes of JPMorgan and Citi.

These are so-called agent or issuer banks, through which
marketplace lenders have channelled loans to get around the
fact that they do not have banking licences. When a borrower
qualifies on an MPL platform, a loan note is issued from the
issuer bank and the proceeds of the loan (minus a fee) passed
on to the borrower. The platform then matches the loan with an
investor in a process that usually takes 24 to 48 hours. Once
the loan has been funded, the platform buys the loan note back
from the issuer bank.

In effect, the online lending platforms rent the regulatory
capital and licences of these banks for 48 hours.

They are doing it a lot.

Warren Lichtenstein,
WebBank

Taking a small cut of each loan it processes, WebBank, owned by
ex-hedge fund investor Warren Lichtenstein, generated net
income of $31 million last year – a return on equity
of 59%. It has just 52 employees. Cross River Bank was launched
by Gilles Gade, a veteran of Barclays and Bear Stearns, in 2008
and had done enough business by October last year to launch a
$100 million securitization of MPL loans originated by Marlette
Funding via Deutsche Bank.

Cosy arrangement

This cosy arrangement has served the sector well. However,
when the Department of the Treasury launched a
request for information on the online lending industry in
July last year, it became clear the good times may be running
out. If there is one thing the regulators learned from the
financial crisis it was that the originate-to-distribute model
in the mortgage industry encouraged lax underwriting because
the originator had little incentive to maintain borrower
quality on loans that it would sell on in their entirety
– exactly what has been going on in the MPL industry
ever since.

Unsurprisingly, the issuer banks have been at pains to play
down any risks in the current arrangement. "From a regulatory
perspective, the origination of [marketplace] loans does not
break new ground," insisted WebBank in its response to the
Treasury RFI. "Indeed, this is a business in which WebBank (and
other banks) have been engaged for many years. It is a model
used for credit-card lending, mortgage lending, student
lending, private-label financing and other credit platforms."
This rather Canutian claim has, however, been shaken by a
recent decision in the courts that has big implications for
marketplace lenders.

Last June, a case was brought against a debt collection firm
Midland Funding by a New York-based plaintiff,
Saliha Madden, who claimed that its attempt to collect her
debt (which carried interest at 27%) breached the Fair Debt
Collection Practices Act. This was because New York usury law
caps annual interest rates at 16%. The outcome of the case,
which has been referred to the US Court of Appeal, found that
while banks can collect interest above usury rates thanks to
protections from the National Bank Act, non-bank lenders
can’t and are subject to the usury law of the
borrower’s domicile. Utah, where WebBank is
domiciled, does not have a cap on usury rates.

That is a problem for MPLs as their rates often breach these
limits. Indeed, in a 2014 earnings call, Lending Club revealed
that more than one in 10 of its loans may exceed them. It
therefore has an urgent need to tie its non-bank loans more
closely to the bank that is issuing them. It will do that by
forcing WebBank to have skin in the game through its
contractual relationship with Lending Club. In future the
issuing banks it works with will maintain a continuing interest
in all Lending Club loans after they are sold on and will
maintain a contractual relationship with the
borrowers.

Renaud Laplanche,
Lending Club

This will be achieved by Lending Club paying its fees to
WebBank in instalments that terminate if the loan stops being
repaid.

In its fourth-quarter earnings call Lending Club CEO Renaud
Laplanche stated: "As a note of caution we are rolling out this
quarter a number of operational and contractual changes to our
relationship with our issuing banks that give us a high level
of confidence that our issuance framework would meet the tests
used in the Madden case if a similar action was ever brought
against us."

He must hope that confidence is not misplaced following a
complaint filed by New York-based Ronald Bethune in early April
over the 29.97% interest rate on his loan from Lending Club.
According to the complaint more than 100 borrowers, many from
other states, are joining a proposed class action lawsuit
against the marketplace lender.

To soften the blow to the issuing banks on which it relies
Lending Club will increase the performance fee it pays to them
in return for tying them in to the loan’s
performance. The Midland decision only applies to loans
originated in Connecticut, New York and Vermont, but it could
be applied elsewhere.

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